Tax Gap Plan - Franchise Tax Board - California Franchise Tax Board

Tax Gap Plan:
A STRATEGIC APPROACH TO
REDUCING CALIFORNIA’S TAX GAP
Issued 2006

Letter From Steve Westly, State Controller
I’m pleased to introduce the Franchise Tax Board’s plan to address California’s tax gap.
Creating a tax system where every taxpayer pays the correct amount of tax—no more and
no less—goes to the heart of our mission to fairly and effectively administer the State’s
income taxes. Each year, however, California taxpayers pay $6.5 billion less in income
taxes than they legally owe. Shrinking this “tax gap” is the goal of this plan.
This new plan builds on a foundation of current, successful enforcement and customer
service programs. Since 2004, the Voluntary Compliance Initiative (VCI) for abusive tax
shelter participants and Tax Amnesty have brought in over $6 billion to California. These
two programs demonstrate the impact that effective tools can have in addressing the tax
gap. But current enforcement programs and initiatives haven’t done enough to narrow the
tax gap. We must embark on a multi-year plan that addresses all of the root causes of the
tax gap. Steps to increase overall confidence in the tax system and reduce the burden and
complexity of complying with the tax laws are included in this approach.
In developing this plan, FTB collaborated with academics, taxpayer groups, tax
professionals, business representatives, legislative staff, and other stakeholders. These
stakeholders deserve appreciation for contributing their time and expertise to improving
California’s tax system. We now look forward to working with our stakeholders to take
action and reduce California’s tax gap.
Sincerely,
STEVE WESTLY
California State Controller
Chair, Franchise Tax Board

3
Table of Contents
4
5
6
8
14
15
16
22
23
INTRODUCTION: Most Of Us Do The
Right Thing—We Pay Our Taxes
ASSESSING THE TAX GAP: Who Is Not
Paying Taxes?
A STRATEGIC APPROACH TO DECREASING
THE TAX GAP
TAX GAP PLAN GOALS
CRITICAL SUCCESS FACTORS
CONCLUSION
APPENDIX 1
Plan Detail and Implementation Schedule
APPENDIX 2
Planning Process and Members of the
Executive Officer Advisory Board
APPENDIX 3
External Sources of Information

4
INTRODUCTION:
Most of us do the right thing—we pay our taxes
Each year, about 14 million individuals and nearly one million businesses voluntarily file their tax returns and
pay their California income taxes. This is 86 percent of all the income taxes owed. This is also the revenue that
provides much of the funding for California’s public services. An additional three percent of income taxes owed is
collected through FTB enforcement actions that compel payment of taxes not voluntarily paid.
This still leaves a “tax gap”—the total amount of taxes owed but not paid—of about 11 percent in a typical year.
This equals approximately $6.5 billion a year in unpaid taxes.
PERCENTAGES OF TOTAL TAX OWED
THE TAX GAP AND PAYMENTS FROM VOLUNTARY COMPLIANCE AND ENFORCEMENT ACTION
Enforcement
Action
Tax Gap
3%
11%
86%
Voluntary Compliance
The failure by some to pay what they owe means that the rest of us bear an additional burden. This can come in
the form of higher fees and taxes, fewer government services, or budget deficits—or all three.
This Tax Gap Plan addresses the problem of unpaid taxes. The plan includes near-term and longer range
actions. These actions, along with some already underway, will have immediate revenue effects. Over the next
three years, the actions will bring in as much as $1.5 billion in taxes that today remain uncollected.
Although we will probably never completely close the tax gap, we believe that the proposed approach will
significantly reduce it.

ASSESSING THE TAX GAP:
Who Is Not Paying Taxes?
Our estimate of the State tax gap is based on the IRS estimate of the federal tax gap, adjusted for California.
However, it is likely that the estimates are low. They are based on incomplete data and do not fully account for
all taxes lost to the underground economy and abusive tax shelters, such as hiding income offshore. For example,
fiscal years 2003-04 and 2004-05 saw revenues higher than typical years due to two special FTB programs.
The Voluntary Compliance Initiative (VCI) brought in $1.4 billion from taxpayers seeking to avoid penalties by
voluntarily paying taxes they had previously avoided through the use of abusive tax shelters. The Tax Amnesty
Program brought in $4.8 billion from other taxpayers who used the opportunity to come into compliance with the
provisions of tax law and thereby avoid penalties.
According to the federal estimate, different segments of the population account for differing percentages of the tax
gap. The chart below shows the estimated shares of the tax gap by filing segment and type of misreporting. Note
that “PIT” stands for Personal Income Tax.
FEDERAL TAX GAP PERCENTAGES
ACCOUNTED FOR BY THE TYPE OF FILER AND NONCOMPLIANCE
Understated tax – Corporations
Overstated deductions,
exemptions, credits – PIT
Non-paying –
PIT and Corporation
Nonfiling – PIT
8%
12%
11%
11%
21%
37%
Underreported income –
PIT Business
Underreported income –
PIT Nonbusiness
As the chart shows, the underreporting of income on Personal Income Tax returns contributes the largest portion
of the tax gap. In fact, the underreporting of business income by personal income taxpayers makes up nearly 40
percent of the total tax gap. The IRS estimates that the majority of this underreported income is from business
sectors that do business largely in cash.
Because so much of the tax gap is still unknown, it is a difficult issue to resolve. Over the years, FTB has
continuously increased the total amount of taxes collected voluntarily and through enforcement. However, the
percentage of taxes owed but not paid has remained constant because the amount of tax owed has also increased.
This plan puts in place a framework for actions that can finally begin to decrease this persistent tax gap.
4 5

6
A STRATEGIC APPROACH
TO DECREASING THE TAX GAP
Our approach to reduce California’s tax gap is to address the primary causes—not just the symptoms—of
the tax gap. We developed goals to address those primary causes and appropriate initiatives to achieve
those goals. This approach balances “soft” approaches and enforcement-oriented approaches. Soft
approaches, such as increasing taxpayer confidence and reducing burden and complexity, narrow the tax
gap by increasing taxpayer willingness to voluntarily comply. Voluntary compliance is a key for making
major inroads into the tax gap. As previously stated, typically, about 86 percent of California’s income tax
revenue comes from taxpayers that voluntarily report and pay their taxes. Increasing that rate by just one
percentage point from 86 to 87 percent would narrow the tax gap by about $500 million.
Enforcement—taking action to compel payment and enforce penalties—also has an important role in
reducing the tax gap. Enforcement increases the rate of voluntary compliance because it gives honest
taxpayers confidence that cheaters get caught. It also deters those who would otherwise find cheating too
tempting.
In addition to balancing soft and enforcement actions, the plan also balances tactical, short-term actions
with more foundational, long-term actions. Here is the difference between the two approaches: Tactical
actions address immediate tax gap issues and generate short-term revenue, primarily through enforcement.
In contrast, foundational activities seek to make lasting changes in taxpayer behavior to increase voluntary
compliance. They also improve FTB’s capacity to respond to future tax gap challenges.
By moving forward to implement new initiatives described in this plan and continuing existing efforts
already underway, FTB expects to collect as much as $1.5 billion in tax revenue over the next 3-5 years
from:
• Nearly $1 billion from targeting abusive tax shelters.
• About $200 million from increased audit activity, including speeding up certain amnesty-related audits.
• About $300 million from new tax gap initiatives that fall into the tactical and foundational
categories listed below.
Tactical:
1.
2.
3.
4.
5.
“Increasing the rate of voluntary compliance by just one percentage point from 86
to 87 percent would narrow the tax gap by about $500 million.”
Conduct more audits.
Focus on preparers that prepare problem returns and that promote sham,
out-of-state incorporations.
Audit issues related to independent contractors.
Use more data sources to detect nonfilers.
Expand the program to find certain business nonfilers.

Foundational:
1.
2.
3.
4.
5.
6.
7.
8.
9.
Target independent contractors with education and outreach to increase
voluntary compliance.
Promote tax compliance through a statewide education campaign based on the successful
Amnesty campaign.
Make changes to FTB programs based on direct input from taxpayers and other
stakeholders on actions that will increase willingness to correctly report and pay taxes.
Make FTB’s information return (1099) program—where those making payments to others
report that information to FTB—easier so we receive more returns.
Revise tax returns to include a line that shows total income covered by information returns.
Devise better audit modeling for catching underreporting of income and enhance FTB’s
ability to track evolving tax cheating approaches.
Integrate FTB’s data systems to improve usefulness for enforcement and voluntary
compliance initiatives.
Increase criminal prosecution for significant abuses of the tax laws.
Use taxpayer tips as leads to find significant noncompliance.
The above actions are a balance of soft and enforcement approaches. When given the choice, FTB
would always prefer to bring in taxes owed to the State through voluntary means rather than resorting to
enforcement. Our recent experience with the tax amnesty and VCI programs indicates that encouraging
voluntary compliance is not only less intrusive on taxpayers, but is also very cost effective. For example,
for an investment of under $13 million, the VCI and the Tax Amnesty Programs brought nearly 175,000
people into voluntary compliance and garnered $4.8 billion from tax amnesty and an additional $1.4
billion from VCI in taxes that otherwise would not have been paid.
However, FTB still needs enforcement methods when voluntary methods fail. We are seeing increasingly
sophisticated techniques for hiding income, and cash businesses are moving further underground. For
example, as of the end of March 2006, FTB’s abusive tax shelter efforts are currently addressing audit
cases with estimated revenue of nearly $1 billion. These efforts required that we develop new audit
methods to find transactions that did not exist 15 years ago.
Regardless of the approach used, we need to be able to measure the success of our methods in decreasing
the tax gap. We also need the resources and funding to pursue the tax gap plan initiatives. A more
detailed explanation of these metrics as well as FTB’s funding request, is included in a separate Budget
Change Proposal that has been submitted to the Department of Finance.
7

8
TAX GAP PLAN GOALS
FTB’s plan contains six key goals, with each goal targeting a primary cause of the tax gap. The goals are
shown on the following pages. For the specific initiatives, objectives, and timeframes for each goal, please
refer to appendix 1.
Goal 1
Improve Taxpayer Confidence in the Tax System
Over the last 20 years, a growing number of studies have concluded that taxpayers’ willingness to
voluntarily report and pay their full, legally-owed tax liabilities increases when they:
• Have confidence that the tax agency uses fair procedures.
• Perceive that the agency treats them with respect.
• Believe that most taxpayers pay what they owe.
It is also important that businesses, including large corporations, have confidence in the tax system.
Willingness to honestly report and pay declines when this confidence is undermined. These
conclusions are consistent with FTB’s experience with taxpayers, tax professionals, and taxpayer
groups. In addition to the perceived fairness of tax agency procedures, it is also important that
individuals and businesses regard paying taxes as part of being good citizens and understand the
important role they play by paying the taxes needed to support essential services.
“Last year, 87 percent [of taxpayers surveyed] said it was not acceptable at all to
cheat, compared to 91 percent in 1999. We must stem this tide; not to do so would
place the entire tax administration system in peril.”
Mark Everson, IRS Commissioner, IRS Oversight Board Annual Report 2004

Goal 2
Make Taxes Less Taxing
Estimates of taxpayers’ annual costs to comply with federal tax laws range from $75 to $265
billion. We know less about the burden of complying with state tax laws. But we do know that the
burden of complying with California tax laws increases when State requirements differ from federal
requirements. That is, when they do not “conform” to federal requirements.
This burden is not equal for all taxpayers. Estimates suggest that small businesses’ costs to comply
with tax laws is a larger share of their total costs than it is for large businesses. In California, many
businesses must deal with more than one State agency to meet all of their tax requirements. In
addition, California’s diverse population suggests that a one-size-fits-all tax system will be easier for
some taxpayers to navigate than others. Immigrants, seniors, college students, independent contractors,
out-of-state taxpayers, and others have their own sets of unique circumstances. FTB needs to collect
more information about different taxpayers’ needs to make it as easy as possible for all California
taxpayers to meet their tax obligations.
Burden and complexity may increase the tax gap in several ways:
•
•
•
•
Complex tax laws can cause well-intentioned, honest taxpayers to make inadvertent errors.
Complex requirements may cause some taxpayers to simply choose not to take all the steps
necessary to determine their true tax liability. This approach can lead taxpayers to underpay, but
can also cause overpayment. Some taxpayers may even drop out of the tax system to avoid the
cost of compliance.
Complexity can lead to differing interpretations by taxpayers and tax administrators, which may
undermine taxpayers’ perception of procedural fairness.
More complex tax laws give dishonest taxpayers more opportunities to conceal tax evasion
through complex schemes.
The goal of reducing burden and complexity is also relevant to the prior goal of increasing taxpayer
confidence in the tax system. Burden and complexity can erode taxpayer confidence, because
taxpayers can view a complex system as less fair and lacking respect for them and their time.
“…simpler taxes would generate more public support and thus should be an
essential part of any effort to improve delivery of government services. The biggest
complaint about the tax system for many people is not the amount of taxes they
pay but rather the sheer, and seemingly needless, complexity of what appear to be
everyday tax situations.”
William H. Gale, Brookings Institute in testimony to Congress 2001
9

10
Goal 3
Make It Harder to Cheat
Studies show that people who think about cheating on their taxes mainly consider two things: the
likelihood of getting caught and how much they’ll have to pay if they do get caught. Unfortunately,
several economic trends are making it harder for FTB to track income and other tax information
needed to detect cheating. These trends include globalization, electronic commerce, offshore banking,
and an increase in the number of independent contractors. We also see evidence that business is
increasingly conducted in cash to hide income.
Information is key to detecting tax cheating. Compliance rates are highest where the IRS and FTB
get data from employers and other third parties about income and other tax information. While FTB’s
traditional enforcement approach has been to crosscheck this data with the information supplied on
tax returns, newer tax cheating methods require that FTB uncover information that is left completely
off the return. Sharing information across agencies and jurisdictions, as well as finding new sources
of data, are increasingly important. Automated tools and systems provide the ability to examine and
compare large quantities of data to detect noncompliance. In seeking information, FTB must guarantee
taxpayers that we will continue to maintain all privacy principles and safeguards.
“Consider what happened one spring evening at midnight in 1987: 7 million
American children suddenly disappeared… It was the night of April 15, and the
Internal Revenue Service had just changed a rule. Instead of merely listing each
dependent child, tax filers were now required to provide a Social Security Number
for each child. Suddenly, 7 million children—children who had existed only as
phantom exemptions on previous year’s 1040 forms—vanished...”
Malcolm Gladwell in Freakonomics

Goal 4
Level the Playing Field for Businesses
IRS tax gap studies show that tax cheating is much more common in some sectors of the economy than
in others, and is generally the worst where taxpayers have the opportunity to conduct business in cash.
When cheating becomes widespread, a snowball effect can occur. Margins in business are often small
and difficult to maintain, so businesses have a temptation to duck tax obligations to help their bottom
line. If most businesses underreport, then competitive markets squeeze prices downward to reflect
lower costs from the tax cheating. Ultimately, the lower prices leave margins that cannot cover taxes
and expenses, so businesses that pay taxes can no longer compete. They must join in underreporting or
go out of business. Even where such market pressure has not developed, lack of confidence in the tax
system may lead to lower levels of correct self-reporting in sectors where cheating occurs.
Future State efforts must respond to this problem to help level the playing field for all businesses.
This includes developing programs that will focus on business sectors where tax cheating has
been identified and is putting honest businesses at a competitive disadvantage. Also, those specific
businesses that are noncompliant with tax law should not be permitted to contract with the State.
“… Additionally they don’t pay any payroll taxes on these people, don’t have
to provide any benefits, and can use these savings to reduce the price of their
products. We are beginning to be unable to compete…”
Business owner in a letter to the State Controller
11

12
Goal 5
Support High Standards in the Tax Professions
Tax professionals play an important part in California’s tax system, preparing nearly 70 percent
of California’s Personal Income Tax returns. Tax professionals understand tax laws and make
fewer mistakes than non-professionals, which helps both taxpayers and FTB. However, honest tax
professionals face increasing competition from unethical providers of tax services.
Tax professionals have always felt pressure from clients who want to prepare returns that do not reflect
the full amount of tax owed. Ethical tax professionals can sometimes lose business to unscrupulous
preparers who are willing to help taxpayers cheat. For example, in 2005, some California tax
professionals expressed frustration that FTB was not doing more to dispute the claims of out-of-state
tax advisors offering to reduce taxes through sham corporations set up in other states. Narrowing the
tax gap requires that FTB work closely with the tax professional community to understand the most
effective ways to support ethical preparers.
“Compliance with California’s complex tax laws requires representation of California
taxpayers by ethical and responsible tax service professionals at all levels.”
California Society of CPAs

Goal 6
Become More Innovative in Attacking the Tax Gap
When FTB and the IRS have effectively focused on specific categories of tax cheating, they have
pushed evaders to use strategies that tax agencies have not yet learned to detect. The rise of abusive
tax shelters in the past decade demonstrated this phenomenon. As tax agencies learned about abusive
tax shelters, aggressive promoters continued to evolve complex financial transactions that are more
difficult to detect. The indicators previously used to select tax returns for audit no longer work on these
evolved transactions. Given the rapidly evolving nature of the tax gap, FTB must develop the ability
to innovate and detect new modes of cheating. FTB’s ability to innovate will be crucial to reducing the
tax gap over the long-term.
“A balanced approach does not ignore areas of noncompliance simply because they
are difficult to deal with. It includes creative approaches to intractable problems.
And it does it on a solid foundation of research, so that valuable and limited
resources are used wisely and effectively.”
Nina Olson, The National Taxpayer Advocate, in testimony to the Senate, July 2004.
13

14
CRITICAL SUCCESS FACTORS
Making significant progress in closing California’s tax gap is a huge undertaking, and FTB recognizes that our
commitment alone won’t make it happen. There are several factors we will need to address to be successful.
We must partner with others. FTB cannot solve the tax gap problem alone. Others have a role and an interest
in reducing the tax gap as well, and wise use of public dollars means building and leveraging partnerships with
those who have relevant skills or insight into helping us reduce the tax gap. This includes elected officials, other
government agencies, taxpayer groups, academic and other empirical researchers, tax professionals and their
associations, software companies, and the business community.
We must leverage federal efforts. A taxpayer’s decision to underreport income or overstate deductions is
often made primarily to avoid federal income tax, because federal tax rates are generally three times as high as
California tax rates. The IRS has recently announced that it believes as much as one-third of the tax gap may
be recovered as a result of activities currently proposed at the federal level. Because federal income tax law
generally serves as the basis for California tax law, California stands to benefit significantly from these federal
tax gap activities.
We must ask taxpayers and tax professionals what they think. As tax administrators, we see the tax
system from the inside out—a critical perspective in figuring out how to close the tax gap, but not the only
one. Taxpayers, tax professionals, and other stakeholders bring a different perspective, which is also critical for
understanding how we can take effective action. To understand the view of the tax system from the outside in,
we must ask taxpayers and others their views about why there is a tax gap and how we can ensure every taxpayer
pays the correct amount of tax.
We must be mindful of unintended consequences. Closing the tax gap is important for California,
but it’s not the only important public policy goal in the State. For example, as we collect and use more data to
detect tax noncompliance, we must maintain rigorous privacy standards. As we look for more sources of income
information, we must take into account that mandated data reporting puts a burden on the third parties who
supply the data—often businesses, including small businesses that can least afford the burden. As we work to
catch tax cheats, we must also be mindful of evidence suggesting that overly aggressive enforcement causes
people to negatively view paying taxes, in general.
We must have sufficient resources and allocate them wisely. FTB will seek to redirect staff to actions
laid out in this plan from current actions with less potential for reducing the tax gap. However, additional
resources may be needed. To obtain the additional resources, we need the support of the Governor and the
Legislature. Also, we must be able to measure the success of our actions in order to justify the long-term fiscal
merit of our efforts.

CONCLUSION
This plan has grown out of the recognition that narrowing the tax gap will require balanced, long-term action
and investment. Current research and experience indicate that the actions proposed in this plan have promise
to reduce the tax gap. As we move forward, we expect discussions about what’s working, what isn’t, and what
new ideas need to be added. These discussions will occur at FTB and with others that will be part of resolving
California’s tax gap—elected officials, administration representatives, large and small businesses, taxpayer
groups, tax professionals, community organizations, and many others.
We look forward to continue our dialogue with our stakeholders, as we work together to put in place a system
in which every California taxpayer pays the correct amount of tax—no more, no less.
15

16
APPENDIX 1
Plan Detail and Implementation Schedule
This appendix provides specific initiatives, objectives, tasks and their
timeframes for each of the six tax gap goals.
Goal 1
Improve taxpayer confidence in the tax system
Ensure that administration of the tax laws is fair, open,
and respectful of taxpayers.
Establish and implement performance measures of fairness,
openness, and respectful treatment of taxpayers in key areas
throughout FTB.
Seek stakeholder feedback regarding FTB’s fairness,
openness, and respect shown to taxpayers.
Communicate more about FTB to make FTB information,
processes, and decisions more transparent to stakeholders.
Use modern communication methods to increase dialogue
between stakeholders and FTB.
Determine the most effective ways to increase
Californians’ confidence in tax administration so that
honest tax reporting and paying increases.
Ask taxpayers, tax professionals, and non-filers what FTB
can do to improve their confidence in the tax system so that
they are most willing to honestly pay taxes.
Investigate and implement a public relations campaign to
change attitudes about social norms regarding taxes, using
campaigns by nonprofit organizations such as MADD,
businesses, and other states and countries as examples.
Conduct research on the potential for appropriately designed
taxpayer appreciation or incentive programs to increase
willingness to honestly report and pay taxes.
Investigate how both non-enforcement and enforcement
programs impact voluntary compliance.
Increase publicity of FTB’s audit and criminal enforcement
activities.
Conduct outreach to California’s diverse communities.
Use diverse staff to work in communities.
Seek out community partners such as AARP and cultural
chambers of commerce to better understand the needs of our
diverse taxpayer population.
Timeframe for Implementation
short-term
0-3 years
mid-term
4-5 years
long-term
5+ years

Give recognition to the majority of taxpayers as
honest and good citizens, who provide the resources
needed to make California a great state.
Test the most promising methods for increasing taxpayer
understanding about the high percentage of Californians
who honestly pay their taxes and about the services these
taxpayers fund.
Conduct an ongoing education program focused on helping
potential new income-earners understand the importance to
California of fulfilling their tax responsibilities.
Goal 2
Make taxes less taxing
Make it easier for taxpayers to correctly file and pay
their taxes.
Provide taxpayers with timely, easy access to their Personal
Income Tax account information.
Provide taxpayers with online, interactive tools to help them
file and pay correctly.
Make California withholding tables more consistent with
federal tables.
Explore methods to help taxpayers track when to pay
estimated taxes and how much they’ve paid.
Continue to work with sister tax agencies to make meeting all
California tax requirements more seamless.
Reduce the burden on taxpayers from FTB’s
administrative systems.
Shorten resolution times for compliance issues.
Distinguish between intentional and unintentional noncompliance
and use appropriate approaches to address each.
Reduce the time between the filing of a return and the
beginning of enforcement activity.
Continue to improve staff’s knowledge and consistent
application of federal/state law differences.
Educate taxpayers about audit issues so they can correctly file
future returns.
Implement business process re-engineering to streamline all
processes so that voluntary compliance is less burdensome to
taxpayers and uses fewer tax dollars to accomplish.
short-term
0-3 years
Timeframe for Implementation
short-term
0-3 years
mid-term
4-5 years
mid-term
4-5 years
long-term
5+ years
long-term
5+ years
17

18
Reduce legal complexity in the tax system.
Assess complexity and compliance burden in the bill analyses
FTB provides to the Legislature.
Be more proactive in providing tax law simplification ideas to
the Legislature for both proposed legislation and current law.
Identify areas of federal law that are too complex and work
with Congress to reduce the complexity.
Educate external policy-makers regarding the additional
complexity faced by taxpayers whenever California tax law
does not conform to federal law.
Explore tools to make it easier for taxpayers and tax
professionals to identify differences between federal and
California law.
Address the unique needs of different taxpayers.
Learn from multicultural taxpayers about any special needs
they may have in navigating tax requirements so FTB can
design and deliver services to meet those needs.
Customize the filing experience to fit taxpayers’
circumstances.
Add more languages to FTB’s Internet site, forms, and
instructions as needed for non-English speakers to understand
and comply with tax laws and ensure FTB’s call-centers have
necessary staff to respond effectively to calls from
non-English speakers.
Goal 3
Make it harder to cheat
Find and stop more instances of noncompliance by using
more data and improving automated systems to use it
more effectively while strictly adhering to FTB’s privacy
policy and principles.
Obtain an independent evaluation of how FTB collects and
uses data, including ways to effectively use more data.
Develop and implement a tax systems strategy to improve our
ability to use information within FTB.
Build the organizational capacity to mine data to identify
noncompliance.
Test the most promising sources of additional information to
determine their usefulness in detecting noncompliance.
Change policy, acquisition procedures, and statutes to
facilitate the use of additional data.
Continue working with other government agencies to better
use data to detect potential noncompliance.
Develop and publicize a process to be more responsive to
informants and their information.
short-term
0-3 years
Timeframe for Implementation
short-term
0-3 years
mid-term
4-5 years
mid-term
4-5 years
long-term
5+ years
long-term
5+ years

Improve our information return (1099) reporting program.
Assess FTB’s information reporting program to ensure that
all mandated reports are used, and make requirements clearer
and reporting easier for our third-party information providers.
Review the potential for acquiring more information returns
through an information return reporting amnesty.
Ensure that all legally mandated information returns are
received and make penalties for failure to report more
practical to administer.
Revise tax forms to include a separate line reporting income
covered by information returns.
Explore the potential to disallow deductions by businesses for
payments to independent contractors when the business has
not given a corresponding information return (1099) to FTB
and seek technical clarifying legislation.
Look for ways to address the specific issues associated
with independent contractors.
Provide education about independent contractor issues to
businesses that hire large numbers of independent contractors and
to the contractors themselves.
Further evaluate the costs, benefits, and equity concerns of
withholding on independent contractors.
Increase speed and coverage of enforcement activities.
Refer more accounts to private collection agencies when it
makes sense to do so.
Further improve FTB’s strategic audit approach for increasing
the number of noncompliant taxpayers audited without
intruding on taxpayers who have correctly reported.
Increase criminal enforcement for significant abuses of
tax laws.
Maximize the effectiveness of penalties.
Review penalty provisions to ensure that they are effective
and applied consistently.
Work with the Legislature to revise penalties that
are ineffective
short-term
0-3 years
mid-term
4-5 years
long-term
5+ years
19

20
Goal 4
Level the playing field for businesses
Develop a program that focuses on sectors where tax
evasion is putting honest businesses at a competitive
disadvantage.
Identify sectors with widespread noncompliance and devise
sector-specific techniques for enforcement.
Gain the confidence of sector businesses that want to comply
through education and effective action against noncompliant
businesses.
Enlist compliant businesses in an education campaign to
promote the understanding that noncompliant businesses hurt
the business climate.
Coordinate actions across all of State government
against businesses that cheat.
Ensure that noncompliant businesses do not contract with
the State.
Partner with other government agencies to reduce
opportunities for noncompliance.
Goal 5
Support high standards in the tax professions
Partner with tax professionals in creating conditions
for maintaining high standards.
Get input from professionals to determine the best ways for FTB
to support ethical behavior in the tax professions.
Improve transparency and communications with tax professionals
so that they have all the information they need to perform
ethically and can promote awareness of compliance issues.
Partner with organizations and agencies related to tax
professionals to address areas of concern.
Work more closely with the Board of Accountancy, other
regulatory bodies, and professional organizations to
address issues.
Make professional practitioner misconduct unprofitable.
Identify problem practitioners and audit the returns they prepare.
Bring more enforcement actions against preparers promoting
sham, out-of-state incorporations.
Timeframe for Implementation
short-term
0-3 years
mid-term
4-5 years
long-term
5+ years
Timeframe for Implementation
short-term
0-3 years
mid-term
4-5 years
long-term
5+ years

Goal 6
Become more innovative in attacking the tax gap
Further develop in-house expertise to combat
tax cheating schemes.
Acquire and share expertise across programs.
Get information on the latest schemes used to avoid paying
taxes by:
1) Making it easier for knowledgeable outsiders to contact
FTB on tax avoidance schemes.
2) Providing amnesty to tax offenders in exchange for
information.
Continually develop new ideas to reduce the tax gap.
Create a roundtable of representatives of corporations to get ideas
to facilitate compliance.
Use contracts with outside experts that pay only for successful
performance in making inroads into the tax gap.
Leverage partnerships with outside research and tax
experts to build cost effective research capabilities.
Establish a roundtable of academic researchers to advise FTB on
research methods and ideas.
Collaborate with external researchers to design and conduct
studies to quantify the effect of specific actions on the tax gap.
Urge the Federation of Tax Administrators and the Multistate
Tax Commission to create a national institute to address tax
gap topics.
Study what other state jurisdictions are doing to address their
tax gaps.
Timeframe for Implementation
short-term
0-3 years
mid-term
4-5 years
long-term
5+ years
21

22
APPENDIX 2
Planning Process and Members of the Executive Officer Advisory Board
The Planning Process
To develop this plan, FTB staff reviewed research and conferred with academic, non-profit, government,
and industry experts on the causes, challenges, and solutions to the tax gap. Using this information and
their own knowledge and expertise, FTB’s planning participants developed a draft plan that was shared
with the Executive Officer Advisory Board for review and comment. The Advisory Board consists of
representatives from 16 different organizations, including tax professional groups, taxpayer associations,
legislative committees, and business groups.
Advisory Board members were generally supportive of the ideas and initiatives in this plan and expressed
particular support for actions to increase enforcement, address the complexity caused by differences in state
and federal tax laws, improve communication and public relations, and increase cultural awareness.
Members’ key concerns included the need to leverage our efforts across government agencies, the challenges
associated with implementing the plan, the interplay between FTB’s efforts to address the tax gap and
our overall mission, and the potential burden on taxpayers and third parties if new legal and reporting
requirements were proposed. FTB made several changes to the plan to incorporate Advisory Board input and
provided it to the three-member Franchise Tax Board for review. A full description of the input received from
the Advisory Board and a list of Advisory Board members follows.
A list of the experts consulted during the initial phase of the planning process is attached as Appendix 3.
On March 1, 2006, the Executive Officer Advisory Board assembled to provide input on a draft of the Tax
Gap Plan created by FTB staff. The Advisory Board represents a cross-section of FTB stakeholders. The
following Advisory Board members attended the meeting:
Kimberly Bott, Assembly Revenue and Taxation Committee
Jim Brandes, California Manufacturers and Technology Association
Dan Crosbie, California Society of Certified Public Accountants
David R. Doerr, California Taxpayers’ Association
Lenny Goldberg, California Tax Reform Association
Martin Helmke, Senate Revenue and Taxation Committee
Don Hug, American Association of Retired Persons
Bronwyn Hughes, California Society of Enrolled Agents
Catherine Apker, California Society of Enrolled Agents (special guest)
Gayle Miller, Senate Revenue and Taxation Committee
Gary Renville, Internal Revenue Service
Bernice Fischer, Internal Revenue Service (special guest)
Charles P. Rettig, State Bar of California, Taxation Section
Gina Rodriquez, Spidell Publishing
Jean Ross, California Budget Project
Kathleen Wright, California State University, Hayward
For a more detailed list of the Advisory Board’s input, please visit www.ftb.ca.gov.

APPENDIX 3
External Sources of Information
Tax Gap Presentations to FTB Staff
Jeff Arkin, U.S. Government Accountability Office (GAO), “Tax Gap Report Summary and Measures to
Address the Tax Gap.”
Joseph Bankman, Ralph M. Parsons Professor of Law and Business, Stanford Law School, “Ideas for Narrowing the Tax
Gap.”
Steven Bonovich, Tax Attorney, Intel Corporation, “Abusive and Potentially Abusive Transactions: How to Detect,
Analyze and Report Them.”
Steven Kolodney, Vice President, State and Local Solutions for CGI-AMS and former State CIO for California and for
Washington, “Strategy in an Era of Strained Resources: A Technology Story.”
Alan Plumley, Technical Advisor, National Headquarters for Research, Internal Revenue Service, “Overview of the
Federal Tax Gap” (teleconference).
Joshua Rosenberg, Professor of Law, University of San Francisco, “A Cognitive Psychology View of Tax Compliance.”
Jean Ross, Director, California Budget Project, “What Can Wage and Income Data Tell Us About the Tax Gap?”
Joel Slemrod, Professor of Business Economics and Public Policy and Economics, University of Michigan, “Questions
and Answers on Why People Don’t (and Do) Pay Taxes” (teleconference).
Literature Consulted
Eliza Ahmed and Valerie Braithwaite, 2005, “Understanding Small Business Taxpayers: Issues of Deterrence, Tax
Morale, Fairness and Work Practice,” International Small Business Journal.
James Alm et al., 1992, “Estimating the Determinants of Taxpayer Compliance with Experimental Data,” National
Tax Journal.
Mark Everson, 2006, “Written Testimony of Commissioner of Internal Revenue Mark Everson before the Senate
Committee on the Budget on the Tax Gap and How to Solve It.”
Adam Forest and Steven M. Sheffrin, 2002, “Complexity and Compliance: An Empirical Investigation,”
National Tax Journal.
Bruno S. Frey and R. Jegen, 2001, “Motivation Crowding Theory,” Journal of Economic Surveys.
GAO, 2005, Tax Compliance: Better Compliance Data and Long-Term Goals Would Support a More Strategic IRS
Approach to Reducing the Tax Gap.
Sharmila King and Steven M. Sheffrin, 2002, “Tax Evasion and Equity Theory: An Investigative Approach,”
International Tax and Public Finance.
J. Scott Moody et al., 2005, “The Rising Cost of Complying with the Federal Income Tax,” The Tax Foundation.
Kristina Murphy, 2005, “Regulating More Effectively: The Relationship between Procedural Justice, Legitimacy and Tax
Non-Compliance,” Journal of Law and Society.
George A. Plesko, 2004, “Corporate Tax Avoidance and the Properties of Corporate Earnings,” National Tax Journal.
Tanina Rostain, “Travails in Tax: KPMG and the Tax-Shelter Controversy,” Research Paper Series 04/05 #25, New York
Law School.
Joel Slemrod, 2004, “Small Business and the Tax System,” in H.J. Aaron and J. Slemrod, eds., Crisis in Tax
Administration, Brookings Institution Press.
Benno Torgler, 2002, “Speaking to Theorists and Searching for Facts: Tax Morale and Tax Compliance in Experiments,”
Journal of Economic Surveys.
Michael Wenzel, 2005, “Motivation or Rationalization? Causal Relations Between Ethics, Norms, and Tax Compliance,”
Journal of Economic Psychology.
23